Summary by Terry Kuhn
Master of Accountancy Program
University of South Florida, Summer 2003
The purpose of this article is to introduce a multicontribution income statement based on the ABC cost hierarchy.
The idea is to compute contribution at 4 main levels:
Goal: To help managers assess different levels of profitability and to measure those effects with respect to strategic and operational decisions.
Traditional models of cost analysis:
1. Unit costs
2. Contribution margin
Unit costs analysis is only limited to the product cost and does not give any insight about the contribution of products, brands, product lines, or facilities despite their relevance to management. (p. 45.)
Traditional contribution margin analysis is apparently a short run analysis where fixed cost allocations are ignored.
Product contribution margin = Price – Variable product costs.
The use of a multicontribution activity based income statement starts where the contribution margin ends. The concept is to separate fixed costs into the four levels introduced in the beginning of this paper, resulting in a contribution margin at each of the four levels as indicated in the graphic illustration below.
Product Contribution Level 1
Traditional (or Incremental) Contribution Margin minus unit-based costs (i.e. machine time, direct labor), batch-based costs (i.e. machine setups, processing purchase orders), and product-based costs (i.e. marketing costs of advertising, promoting, & selling particular product that are a direct result of the product sustaining activity)
Product Lines Contribution Level 2
Product contribution minus brand-based costs (i.e. R&D for a brand; advertising & promotion of a brand), and product-line costs (i.e. product line related R& D; technological development)
Excess capacity costs (overcapacity) is a key ingredient in the activity based income statement. While the actual machine utilization is assigned or traced at the product level, any excess capacity costs (the costs of products the company did not produce) are charged according to usage intent and the level of machine specialization. (p. 50)
Operations Contribution Level 3`
Product-line contribution minus customer-sustaining costs (i.e. sales calls) channel-sustaining costs (i.e. catalogues, market research channels)
Simply put, this means that the costs of marketing and sales operations not directly related to individual products are subtracted out.
Facilities Contribution Level 4
Operation contribution minus production facility costs (i.e. plant mgt., personnel, housekeeping), marketing facility costs (i.e. company wide market research, facility level sales & marketing), and administrative facility costs (i.e. general facility mgt., legal, public relations).
According to Ali, an activity-based income statement reveals the profitability of units, products, product lines, customers, channels, operations and facilities, providing information for make-or-buy decisions, to drop or keep products, and various other decisions related to improving efficiency and the adoption of advanced manufacturing technologies.
Kaplan suggested something like this in Robinson, M. A., ed. 1990. Contribution margin analysis: No longer relevant/strategic cost management: The new paradigm. Journal of Management Accounting Research (2): 1-32. Summary of Kaplan and Shank arguments).
Other related summaries:
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Cooper, R. 1990. Implementing an activity-based cost system. Journal of Cost Management (Spring): 33-42. (Summary).
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